As many people do when discussing the complex world of cryptocurrencies, Vladimir Putin kept it simple: “Of course, we also have certain competitive advantages here, especially in the so-called mining.” After events this weekend, when Russia was hit by severe financial sanctions, the Russian president might be considering capitalising on those advantages.
Putin was speaking in January, days after the country’s central bank proposed a blanket ban on cryptocurrency trading and mining. In the case of bitcoin, the cornerstone cryptocurrency, mining is the energy-intensive process by which computers verify new bitcoin transactions – putting them on a virtual ledger known as a blockchain – and generate new bitcoins as a reward for that work.
The Bank of Russia was emphatic in its warning, saying that cryptocurrency mining entailed “significant risks for the economy and financial stability.”. One week later, Putin appeared to be less sure, pointing that Russia had advantages in cryptocurrency mining due to its huge energy wealth and expertise in the field.
Putin’s doubts about a full crypto-embargo might well have deepened after the west applied massive pressure to Russia’s financial system with new sanctions. The EU, US, UK and Canada have targeted the country’s $640bn (£478bn) in foreign currency reserves – a financial buffer held as a back-up to deal with emergencies and provide financial stability – by agreeing to “prevent the Russian central bank from deploying its international reserves in ways that undermine the impact of our sanctions”.
The same group have also announced that unnamed Russian banks will be expelled from Swift, the main global payments messaging system used by banks to make cross-border money transfers.
Russia and its banks could be looking at cryptocurrencies more closely because they could represent an alternative medium of international exchange to the dollar. Cryptocurrencies could also bypass the international banking system that is key to enforcing sanctions as a listening post for financial transactions worldwide (a characteristic of cryptocurrencies that watchdogs and central banks dislike), by offering an alternative way to make irreversible cross-border transactions.
“We’re at a watershed moment in global history where central banks of nation-states are no longer in direct control of the financial instruments once used to impose global regulations. With cryptocurrency in its infancy, these decentralised currencies lack the agency and infrastructure needed for the ability to regulate institutions as large as Russia,” says Eric Michaud, co-founder of Off The Chain, a blockchain security conference.
Other crypto experts argue, however, that the transparent nature of blockchains makes it difficult for sanctioned entities to use cryptocurrencies to bypass sanctions.
Nonetheless, some nation states have turned to bitcoin for an escape. Iran, heavily sanctioned by the US but with substantial fossil-fuel reserves, effectively converts its excess energy into cash by acquiring bitcoins off Iran-based bitcoin miners (powered by fossil-fuel generated electricity) and using the currency to buy imports.
“The Iranian state is … effectively selling its energy reserves on the global markets, using the Bitcoin mining process to bypass trade embargoes,” said Elliptic, a blockchain consultancy that helps clients combat crypto-related crime, in a blog post last year.
Elliptic’s director of policy and regulatory affairs, David Carlisle, says crypto mining is “one of the most feasible options” for Russia, which is already the third-largest country for bitcoin mining according to data from the University of Cambridge.
“In addition to actually minting crypto that can be used to trade with governments, Russia can tax the underlying money activity as well. They can license and tax the activity itself,” says Carlisle. Elliptic estimates that the Iranian government could make about $1bn a year from Bitcoin mining. Carlisle adds: “Once it’s in possession of large amounts of bitcoin that it’s mined, Russia can then use that Bitcoin to pay for imports of goods and services that it might otherwise struggle to access, owing to US and European restrictions.”
However, the Wall Street Journal reported last week that the US is considering imposing sanctions on Russia’s cryptocurrency market. Companies such as Elliptic offer software that lets businesses spot illegal crypto transactions.
According to Chainalysis, a blockchain analysis firm, the transparent nature of blockchains makes it difficult to use cryptocurrencies as a basis for cloak-and-dagger sanctions dodging. “Sanctions evasion activity is captured on public, permanent, immutable blockchain ledgers,” says Caroline Malcolm, head of international public policy and research at Chainalysis.
Yesterday, the U.S. Treasury Department announced extensive sanctions against Russian businesses and elites following the country’s invasion of Ukraine. This has prompted many to ask Chainalysis how Russia may attempt to use cryptocurrency to evade sanctions.
— Chainalysis (@chainalysis) February 25, 2022
There remain other paths that Russian actors could use, including the North Korean route of hacking cryptocurrency platforms, which raised $400m for Kim Jong-un’s state last year alone, according to Chainalysis.
There are also ransomware attacks, where criminal groups encrypt a target’s computers and demand cryptocurrency in exchange for unfreezing them, although Russia’s FSB security agency recently claimed to have dismantled the REvil ransomware group. Last year, the US treasury department sanctioned two Russian-owned cryptocurrency exchanges, SUEX OTC and Chatex, for allegedly helping launder ransomware proceeds. On Monday, crypto exchange Binance said it was blocking the accounts of any Russian clients targeted by sanctions.
According to Elliptic’s Carlisle, the Russian state could use a network of exchanges to conceal crypto ownership. “If the Russian government or Russian entities wanted to look to ways to evade sanctions using crypto, they could try to develop a network of complicit exchange services that would help them do that,” he says. There are also cryptocurrencies that are difficult to trace, such as the privacy-focused Monero.
But Carlisle adds that the sheer scale of the financial restrictions facing Russia is such that cryptocurrencies will not suffice. “Crypto alone will never enable Russia to circumvent financial restrictions at the scale it needs to mitigate the full impact of restrictions; Russia’s total banking sector assets are $1.4tn – nearly the size of the entire crypto market.”
There are also alternatives to cryptocurrency. Ejecting Russian banks from Swift could encourage China to strengthen its own nascent payment network, Cross-Border International Payments System. Alexi Drew, a senior analyst at RAND Europe, a research institute, says: “It would not be beyond the bounds of belief that China takes the Russian line on sanctions being unfair and provide a means to alleviate them by giving Russia the use of CIPS.”
Or the answer might be even closer to home. The Bank of Russia is developing its own digital rouble too.